The Case for Shorting Bank of America

Should the bear market in US equities resume in the coming months, which I think it will, Bank of America (BAC) may be an excellent shorting opportunity. Here's why:

1. The stock has a beta of 2.41 -- quite high. High beta stocks will be appealing to short for those who are very confident in a forthcoming bear market, as a higher beta suggests greater volatility and a more powerful move in the direction of the overall market trend.
2. A P/E ratio of 38.18, more than twice that of the S&P 500, seems a bit excessive in my opinion -- doubly so when one considers that BAC is a mature company in a troubled industry (banking). Based on P/E ratio alone, I would expect price to fall by 50%.
3. The technicals are particularly appealing, in my opinion. Below is a daily chart. Note the RSI divergence -- prices make new highs, but RSI does not. This suggests the uptrend is running out of strength. We also see a doji and an inverted hammer in the last two candles -- this fact, coupled with the rangebound price action, also suggest the uptrend is running out.

On the weekly chart (see below), we also see RSI divergence. The weekly chart also shows resistance at around 18.30, with support at 12.30. This creates an opportunity to short at a favorable risk/reward ratio -- the stop-loss order can be placed just above resistance, with the profit target being support.

Disclosure: No position.

Comments

[castle:]

Case for shorting Apple---next, case for shorting Google, now case for shorting BAC. Pattern developing here. Are you actually short any of these stocks??

Aug 19 06:21 AM

[Roger Knights:]

BAC is much more profit-leveraged to the economy than the tech stocks, so it's a far better candidate. (Don't overlook WFC, another very leveraged bank.)

Aug 19 07:14 AM

[castle:]

I think BAC and WFC all have fundamentals worthy of a "short" look with WFC being the better choice. WFC chart simply looks weaker. The author has written several articles lately presenting a case for shorting different stocks but I could not find in the disclosure where he had actually done so. Nothing negative intended, a resonable question I thought


On Aug 19 07:14 AM Roger Knights wrote:

> BAC is much more profit-leveraged to the economy than the tech stocks,
> so it's a far better candidate. (Don't overlook WFC, another very
> leveraged bank.)

Aug 19 07:52 AM

[JosephN:]

Shorting on technicals is like russian roulette. You have to look at the fundamentals.

On fundamentals, BAC is still trading below tangible book value and being a huge multinational bank there are money managers that will have to buy this bank as the economy turns as they are required to match this or that index. Throw in the fact that housing has bottomed and the fees from refinancing mortgages for some real earnings power and you'd be insane to short BAC.

WFC does look weaker though, trading above tangible book value and being USA centric with little overseas exposure. There is also a Buffett halo with WFC for what that might be worth. Maybe you could squeeze a small profit here on the short side.

Really though, shorting banks was last year's trade. This year's trade is to buy and hold the financials tight.

(long BAC)

Aug 19 08:24 AM

[District Ba...:]

I don't know where to start with your post, Joseph.

I agree, on a TBV basis, BAC is not that expensive. (As an aside to the author - TBV multiples are how bank investors look at these animals today - NOT P/E multiples.) But let's think about WHY BAC might be trading at a discount.... could it be CFC and the exposure to CA real estate that it added to the balance sheet? Could it be the toxic waste dump that was MER? Could it be constant rumors of Lewis being pressured to resign? Could it be the other shoe that is looming: commercial real estate?

In any case, while I agree that when looking at a short, you MUST focus on fundamentals, (and WFC is many attributes of a potential short) - I reject your statement that "you'd be insane to short BAC."

That's just a little over the top.


On Aug 19 08:24 AM JosephN wrote:

> Shorting on technicals is like russian roulette. You have to look
> at the fundamentals.
>
> On fundamentals, BAC is still trading below tangible book value and
> being a huge multinational bank there are money managers that will
> have to buy this bank as the economy turns as they are required to
> match this or that index. Throw in the fact that housing has bottomed
> and the fees from refinancing mortgages for some real earnings power
> and you'd be insane to short BAC.
>
> WFC does look weaker though, trading above tangible book value and
> being USA centric with little overseas exposure. There is also a
> Buffett halo with WFC for what that might be worth. Maybe you could
> squeeze a small profit here on the short side.
>
> Really though, shorting banks was last year's trade. This year's
> trade is to buy and hold the financials tight.
>
> (long BAC)

Aug 19 10:10 AM

[Novice Trader:]

Please short this stock, with lots and lots of money.

Aug 19 10:21 AM

[JosephN:]

Actually, its because of BAC's exposure to california real estate that I believe it is a buy. Its one reason I think BAC, JPM, and WFC have all had nice runs. Exposure to california home real estate is now a positive rather than a negative in my opinion.

I live in Orange County, CA. Probably one of the 'worst' areas of the housing bubble pop and I'm telling you it is over with here. People are buying or refinancing and the banks exposed to the market here will do very well on fees. I've even heard people are flipping foreclosures after only a few weeks from buying them at auction for 20-30% profits.

If Lewis were to go I suspect there would be a pop up in price rather than a pop down. So I'm not worried there either. Commercial real estate so far has been a red herring for keeping people out of the financials while others (like me) loaded up, but so far so good. Only the closing of the car dealerships really has me worried on that front, as these dealerships often occupy large amounts of prime land in central locations.

In any case, if you think 'insane to short BAC' is a little over the top that certainly is your opinion. Short interest in BAC looks to be around 1%, so maybe we could just agree that it looks like the smart money isn't taking the short side on BAC here.

On Aug 19 10:10 AM District Banker wrote:

> I don't know where to start with your post, Joseph.
>
> I agree, on a TBV basis, BAC is not that expensive. (As an aside
> to the author - TBV multiples are how bank investors look at these
> animals today - NOT P/E multiples.) But let's think about WHY BAC
> might be trading at a discount.... could it be CFC and the exposure
> to CA real estate that it added to the balance sheet? Could it be
> the toxic waste dump that was MER? Could it be constant rumors of
> Lewis being pressured to resign? Could it be the other shoe that
> is looming: commercial real estate?
>
> In any case, while I agree that when looking at a short, you MUST
> focus on fundamentals, (and WFC is many attributes of a potential
> short) - I reject your statement that "you'd be insane to short BAC."
>
>
> That's just a little over the top.

Aug 19 10:34 AM

[District Ba...:]

Since when is the "smart money" decided by what the masses do? These are the same people that got toasted in 2007 and 2008.

As for your comment on Lewis, I agree that it could actually take some overhang off of the stock - but that's difficult to quantify/measure. Could go either way.

Bear markets never (EVER) go straight down, and banks are renegotiating CRE loans at a furious pace. You keep loading up... I need someone on the other end of my short sells!


On Aug 19 10:34 AM JosephN wrote:

> Actually, its because of BAC's exposure to california real estate
> that I believe it is a buy. Its one reason I think BAC, JPM, and
> WFC have all had nice runs. Exposure to california home real estate
> is now a positive rather than a negative in my opinion.
>
> I live in Orange County, CA. Probably one of the 'worst' areas of
> the housing bubble pop and I'm telling you it is over with here.
> People are buying or refinancing and the banks exposed to the market
> here will do very well on fees. I've even heard people are flipping
> foreclosures after only a few weeks from buying them at auction for
> 20-30% profits.
>
> If Lewis were to go I suspect there would be a pop up in price rather
> than a pop down. So I'm not worried there either. Commercial real
> estate so far has been a red herring for keeping people out of the
> financials while others (like me) loaded up, but so far so good.
> Only the closing of the car dealerships really has me worried on
> that front, as these dealerships often occupy large amounts of prime
> land in central locations.
>
> In any case, if you think 'insane to short BAC' is a little over
> the top that certainly is your opinion. Short interest in BAC looks
> to be around 1%, so maybe we could just agree that it looks like
> the smart money isn't taking the short side on BAC here.
>
> On Aug 19 10:10 AM District Banker wrote:

Aug 19 11:04 AM

[JosephN:]

Best stretch those legs out and remain nimble, because if you are part of that 1% you might want to jump out of the way of the steamroller as it comes down the tape.


On Aug 19 11:04 AM District Banker wrote:

> Since when is the "smart money" decided by what the masses do? These
> are the same people that got toasted in 2007 and 2008.
>
> As for your comment on Lewis, I agree that it could actually take
> some overhang off of the stock - but that's difficult to quantify/measure.
> Could go either way.
>
> Bear markets never (seekingalpha.com/symbo...) go straight
> down, and banks are renegotiating CRE loans at a furious pace. You
> keep loading up... I need someone on the other end of my short sells!
>

Aug 19 11:12 AM

[Nom De Plum:]

Have you seen the yield curve??? You don't short bank stocks when the yield curve is this steep. It's like shorting a bookmaker during the superbowl. If I can borrow deposits at 0.5% and lend at many multiples higher than that, it's tough to short that kind of business. Banks won't be a short until the yield curve flattens....why do you think the subprime king Paulsen went long the sector?

Aug 19 11:14 AM

[E Nuff Sed:]

I don't think there is a case for shorting BAC or even C because the government is behind them, the yield curve is steep and mark to market is not coming back for a while. Too risky.

Aug 19 02:37 PM

[Bill L.:]

My concern with the conglomerates is the government's plan to ease systematic risks once the banking secotr is stabilized. The weaker banks like Citi might be forced apart especially their market making functions from their retail banking, etc, thus making any current eps forecasts very unreliable. I expect some sort of Glass-Steagall clone in the near future, and as such the weaker banks that could be affect ei Citi should be avoided. BAC fairs better since they didn't take on as much risk but still fall in the category. At the risk of sounding like a conspiracy theorist, GS is probably the best bet in the financial sector as they proved to be the most maneuverable ship in the sea, as well as having a lot of "inside" help if you know what I mean. This sector will be volatile for years to come, be careful.

Aug 19 02:54 PM

[Bill L.:]

Not to pick on you, but I remember three years ago when the yield curve was inverted, no one paid any attention to its statistical correlation with the stock market. In fact, their were arguments that this was a positive for as the yield curve normalized, banks would be even more profitable, without ever taking into consideration the events that historically transpire that reshape the yield curve.

Personally, this is only a positive if banks are lending thus spreading the benefit of lower borrowing cost to small business that repair the economy. I think there is more evidence to suggest the banks are just giving the money to their hedge funds to speculate in futures markets. But I agree that in the long term a positive slopping yield curve is a plus for equities.


On Aug 19 11:14 AM Nom De Plum wrote:

> Have you seen the yield curve??? You don't short bank stocks when
> the yield curve is this steep.

Aug 19 02:58 PM

[carey_jim:]

Patel, you're just one more smart, reasonable guy trying to make sense out of the nonsensical.

I thought BofA should have gone bankrupt a generation ago when its stock got almost as low as it did recently.

But then I came to my senses and realized that Americans would never allow Bank of America go bankrupt simply because of its name. Most Americans think Bank of America is an American national treasure even though you and I know it is a very poorly run private cash generating machine for its top executives and should have been allowed to die a natural death with all those other financial institutions. (Whatever happened to SKF?)

After BofA bought another moribund entity, Merrill Lynch, I thought it was certainly finished .... for about five minutes.

Shorting Bank of America is just one more crap shoot.

Aug 19 03:00 PM

[LIVE FREE O...:]

There is a reason BAC dropped to $3.50 within the past 12 months. WFC, COF, AXP, etc. are so inflated it is not even funny.

As this bubble pops (no different then the last 12 month period), this stock and the other financials will be sucking wind and revisit the single digits.

The fundamentals are horrible on these stocks (even with gov't intervention) and the economy is worse then last year at this time.

We never seem to learn from history.

Look at the charts, fundamentals, etc., this is setting up perfectly for another Sept/Oct. disaster and "smoke and mirrors" practiced by these banks will not shield them.

And yes, I shorted COF and WFC (these positions are already paying off) several times in the past 2 weeks.

Aug 19 03:19 PM

[Archman Inv...:]

Tough to short this stock, or any stock for that matter that are backstopped by the government. That is really the bottom line.

Since I don't like to rationalize things I will just say it like it is:
BAC, WFC, COF, even GS were bankrupted by the collapse. The government stepped in and saved them. Not only saved them, but have assured everyone that no matter what, they cannot and will no go under.
Anyone who thinks otherwise better wake up or grow up. The banks are not lending, they are hoarding money, and their real businesses are not growing. If it weren't for taxpayer backstopped TARP money used for trading these banks would be gone.

I am not short any of these stocks, nor am I long. I cannot invest in companies that I know are actually controlled and manipulated by others in that way. There are way to many other investments out there.

Short of a complete collapse or loss of faith in our treasury, FED, and our country, sure these stocks might fall and there might be a shorting opportunity somewhere, but I wouldn't own them.

Aug 19 03:29 PM

[mallarde:]

A case for shorting the banks: the main driver of their earnings growth -- mortgages -- is gone. Sure, they can speculate in the futures markets, etc., but how can they grow as Wall Street expects? Merely surviving will not be enough to sustain such weighty valuations.

If the banks return to their traditional role as lenders and deposit-holders, their earnings will not have the growth that gets lofty valuations.

I am short WFC (very small position), and admit I know less about this sector than about everyone that posted above. So please have at it.

Aug 19 03:43 PM

[market mojo:]

is John Paulson smart money enough for you? He now owns 2% of BAC.


On Aug 19 11:04 AM District Banker wrote:

> Since when is the "smart money" decided by what the masses do? These
> are the same people that got toasted in 2007 and 2008.
>
> As for your comment on Lewis, I agree that it could actually take
> some overhang off of the stock - but that's difficult to quantify/measure.
> Could go either way.
>
> Bear markets never (seekingalpha.com/symbo...) go straight
> down, and banks are renegotiating CRE loans at a furious pace. You
> keep loading up... I need someone on the other end of my short sells!
>

Aug 19 04:01 PM

[bbro:]

No discussion of non performing assets,loan loss reserves,loan
chargeoffs, delinquency rates.....you took the lazy man's approach.....

Aug 19 04:23 PM

[Andrew Butter:]

Isn't an important issue that no one, not even BAC really know what the toxic assets they hold will turn out to be worth?

My suspicion is that bad as they are they will turn out to be worth more than the market has nominally valued them at.

I agree shorting was yesterday's game, hold is probably sensible, long I think is a gamble, there just isn't the information, and I would be surprised to see any upside justifying that risk.


On Aug 19 08:24 AM JosephN wrote:

> Shorting on technicals is like russian roulette. You have to look
> at the fundamentals.
>
> On fundamentals, BAC is still trading below tangible book value and
> being a huge multinational bank there are money managers that will
> have to buy this bank as the economy turns as they are required to
> match this or that index. Throw in the fact that housing has bottomed
> and the fees from refinancing mortgages for some real earnings power
> and you'd be insane to short BAC.
>
> WFC does look weaker though, trading above tangible book value and
> being USA centric with little overseas exposure. There is also a
> Buffett halo with WFC for what that might be worth. Maybe you could
> squeeze a small profit here on the short side.
>
> Really though, shorting banks was last year's trade. This year's
> trade is to buy and hold the financials tight.
>
> (long BAC)

Aug 19 04:36 PM

[District Ba...:]

Yeah - real tough to remain nimble in BAC.

Please.... bandwagons abound on this thread.

Aug 19 04:39 PM

[mikebrah:]

Being backed by the government doesn't make it a good investment. It just means it won't go to 0. But look at FNM and FRE. Those are government backed. Or GM, or C or AIG. That could realistically happen to BAC.

Government sponsorship isn't a business model that INVESTORS will applaud long term. Sure, the top executives, directors, etc. will make out handsomely from the government tit. But that's not exactly strong motivation for rational investors to hold or open new long positions in this stock.

If the Post Office had an IPO tomorrow, would you buy it?

MM

Aug 19 08:27 PM

[Ricard:]

This is not correct. Orange county is relatively insulated from the housing bust. I also live in California, and although I don't live in Stockton, Riverside, or Sacramento, I know that those areas are the real danger zones. Entire cities and communities are facing waves of foreclosures and underwater homes. Stockton is now the nation's fifth most dangerous city to live in. Orange county is paradise by comparison.


On Aug 19 10:34 AM JosephN wrote:


> I live in Orange County, CA. Probably one of the 'worst' areas of
> the housing bubble pop and I'm telling you it is over with here.
> People are buying or refinancing and the banks exposed to the market
> here will do very well on fees. I've even heard people are flipping
> foreclosures after only a few weeks from buying them at auction for
> 20-30% profits.

Aug 20 12:15 AM

[Tim9:]

I'm a buyer of BAC,,,,in @ 14.80,,,,IMO,,,the earnings potential are astounding. Of course,,,everything depends on ones view of the economy. Is the glass half full,,,,or half empty.
Personally,,,I see it as being half full,,,,and the worst is behind us.

Aug 20 11:55 AM

[vvvvviking:]

John Paulson is a one-trick pony. Other than getting one massive bet correct, what else has he done?


On Aug 19 04:01 PM market mojo wrote:

> is John Paulson smart money enough for you? He now owns 2% of BAC.
>

Aug 20 05:00 PM

[Ames Tiedeman:]

Great article. I noticed the divergence too and have wondered what is going on. It is not just the RSI. Look at the MACD on BAC. It has been in decline in the face of a rally in the shares since August 6th.

Aug 23 12:24 PM

[Ricard:]

DOW.


On Aug 20 05:00 PM vvvvviking wrote:

> John Paulson is a one-trick pony. Other than getting one massive
> bet correct, what else has he done?

Aug 23 01:42 PM